I'm getting confused about how exactly does money being created by the Fed.

From investopidia.com:

The Fed could initiate open market operations (OMO), where it buys and sells Treasurys to inject or absorb money.

If the Fed holds the Treasurys until maturity doesn't it need to be paid back the par? So how exactly does extra money being created?


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    $\begingroup$ You’ve asked seven or eight questions, some of which have been answered before. I’d recommend narrowing this to a single question that hasn’t yet been answered. $\endgroup$ – dismalscience Jun 13 '20 at 16:34
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    $\begingroup$ To amplify the previous comment, you literally have two questions in your question title. $\endgroup$ – Brian Romanchuk Jun 13 '20 at 17:25
  • $\begingroup$ You reduced the number of questions in the text, but the title is still two questions. $\endgroup$ – Brian Romanchuk Jun 13 '20 at 20:40
  • $\begingroup$ Sorry, corrected $\endgroup$ – user3921 Jun 13 '20 at 20:48

Yes, it does. Maturing bonds held by the Federal Reserve are repaid by the Treasury, just as they repay any other creditor.

However, the cost to the Treasury of doing this is a policy decision of the Fed and can be effectively zero. It’s critical to understand that the Fed’s excess profits are paid to the Treasury. Last year, they paid $54.9 billion to the Treasury. As a result, the vast majority of the money that the Treasury “pays back” to the Fed flows right back to the Treasury.

To dig a little more into the dynamics, the Fed often decides to reinvest the repaid principal on a bond, so as to not reduce the aggregate money supply (you can think of this as choosing to keep rates lower). When they do this, the actual impact on the Treasury is approximately zero. If they choose not to do so (if they choose to allow borrowing costs to rise), the demand for Treasury debt is reduced accordingly, and the Treasury’s borrowing costs will rise.

  • $\begingroup$ Oh wow. I never considered that the Fed’s profits were paid back to the Treasury. This means that all the bonds on the Fed’s balance sheet are effectively 0% interest. Does Japan and the ECB also pay their profits on their private sector bonds back to the government? $\endgroup$ – Keith Knauber Jun 14 '20 at 20:16
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    $\begingroup$ @KeithKnauber Yes, the BoJ repays their Treasury, and the ECB pays profits to member states' central banks, all of which to my knowledge pass that on to their national treasuries. $\endgroup$ – dismalscience Jun 15 '20 at 1:49
  • $\begingroup$ Wow, so private enterprise gets a raw deal. IMO that goes a little too far concentrating power in the hands of government. $\endgroup$ – Keith Knauber Jun 15 '20 at 1:51

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